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Wednesday, July 9, 2014

Difference between Public Provident Fund (PPF) and Fixed Deposit (FD) for Long term

In this article, we will understand the difference between two of the best investment option of conservative investors, PPF or Public Provident Fund and Fixed Deposit, known as FD. Both PPF and FD provides the capital guarantee and considered the safest investment. PPF is even backed by the government while FD is backed by banks and RBI, but which one is better for long term investment. Where should one put his hard earned money for long-term growth with a guarantee, we will find it for this post?
Another day, one of my friends was asking me for an investment option, where he can put money for his daughter's education. His daughter is currently 4 years old, and he wants to save money for higher education. It means she will need money when she would be 17 to 19 years old, which gives us time horizon of 13 to 15 years. My first suggestion to him has put this money on Equities because we are talking about long-term, and I believe given India's growth prospect for next 15 years, equities are the best investment option.

Unfortunately, my friend is very conservative about money, he is OK with earning less interest but not comfortable with losing his hard earned money. So I suggested him about PPF or Public Provident Fund and long term Fixed Deposit with any public sector or private sector bank. To my surprise he was completely unaware of PPF and didn't have PPF account either.

He was quite familiar with FD and convenience, guarantee and the current interest rate it offered, but again he wasn't aware of taxation on fixed deposit and returns after tax. That encouraged me to write this blog post, not just for him but for other people who knows about PPF and FD but doesn't know crucial details which matter. By the way, if you are an NRI investor then you got one better option, NRE fixed deposit, which is completely tax-free.

Difference between PPF and Fixed Deposit

I like point based discussion, the point seems to make a point to me :), So I will present what I know about this safe financial investment in point format. As I said, I am not a financial expert rather than a common man which has an interest in personal finance (I guess, everybody should have), you are always welcome to share your thoughts and knowledge with us. One purpose of having this blog is to learn from other's experience as well. One thing you should know is that, just like FD, you can also open PPF account online with SBI and ICICI bank. It's a good option given convenience attached.

1) Locking Period

First and foremost difference between PPF and FD is that Public Provident Fund or PPF has a locking period of 15 years, while Fixed deposit doesn't have any locking period. Though you will be asked to pay a penalty if you break FD before their maturity period, which is often less interest rate than committed. This is usually from 0.5% to 1%. So If you need money anytime in future before maturity, FD is better option than PPF.

2) Interest Rate

PPF seems to offer 50 basis point more interest than long term FD. This is not guaranteed, but this is how it has from past few years. Currently, major banks like ICICI, HDFC Bank, SBI, AXIS are offering interest rate in the range of 8.25 , 8.50 to 9.00 percent rate, which is also quarterly compounded and gives yield in excess of 12% per annum. For Senior Citizen this is even higher as most of the bank gives them addition 0.5 to 1% on interest rates. On the other hand, PPF currently offering interest rate around 8.75% per annum but it's annually compounded. Don't forget to check's bank's website for latest interest rates, as it varies more frequently than you can think of.

4) Tax Saving on Investment

This is another benefit of PPF. Amount up-to one lakh is exempted from taxable income under section 80C. This can significantly help you to bring your tax slab down and can save a lot of money. FD also has similar benefit via Tax Saver FD, but that is also up-to maximum 1 lakh and has locking period of 5 years.

3) Tax on Maturity

This is the biggest plus point of Public Provident Fund in India. All money you get on maturity is tax-free, you don't need to pay any tax. This is a huge benefit given 30% tax rate in India. Since you will give around 28 lakh, if you invest 100,000 every year, you are saving almost good amount on on tax. On the other hand, interest earned on FD are taxable on maturity. Actually, the bank will deduct tax at source at a rate of 20% (if you don't have your PAN registered with the bank, otherwise 10%) every year if they exceed more than 10000. This tax on maturity on FD effectively reduce an average 8% interest rate to meager 6.0 to 6.5%. Because of only this reason, I think saving 1 lakh every year on PPF is good decision. By the way, if you are an NRI Investor, then consider investing on NRE Fixed deposit, it's completely tax free and no TDS is deducted.

5) Tenure

PPF has fixed the tenure of 15 years, which can be further extended in blocks of 5 years each for any number of blocks. The extension can be with or without contribution. An account holder, continuing with a fresh subscription, can withdraw up to 60% of the balance to his credit at the commencement of each extended period in one or more installments but only once in a year. Fixed deposit is better here, you can option fixed deposit from 6 months to 10 years in any public or private sector bank.

Though I would suggest using your net banking account and option FD only with reputed big banks e.g. SBI, ICICI, Axis bank or HDFC bank. For long term choose 10 years because that's the maximum tenure of FD. To cover longer tenure open new FD every year until maturity period fits your bill. For example, if you want to invest 20 lakhs, you can open 10 years FD with half amount and then after few years you can open another 10 years FD with half amount.

6) Investment Amount

Unlike Fixed deposit, where you are free to invest how much money you want, you can only invest up to Rs 1 lakh in PPF. If you are found to invest more than that amount, the interest earned by excess amount will be reversed. This is a very limiting factor given the high cost of everything in India. I mean if you invest Rs 1 lakh every year, the maximum you can invest is 15 lakh which will give you maturity amount will be somewhere around 28 lakh Rupees. Given inflation, this may not be sufficient for marriage or higher eduction after 15 years. But given you can only have a 10 year FD, PPF seems a good option for a longer period. Alternatively, you can do multiple FD's to cover that period. PPF also has minimum investment amount which is 500 per year. You can put your investment up to 1 lakh in maximum 12 installments.

7) Safety Guarantee

Both PPF and Bank Fixed Deposit are an extremely safe financial instrument, especially if you put your money on big banks like State Bank of India, ICICI bank or HDFC Bank, as this reduce bank default risk. FD is also guaranteed bye Deposit Insurance and Credit Guarantee Corporation (DICGC). However, DICGC guarantees amount up to ₹ 1,00,000 (about US$ 1600) per depositor per bank. On the other hand, PPF is established by Central Government so risk is very low.

That's all about the difference between Public Provident Fund (PPF) and Fixed Deposit (FD) in India. If you consider tax benefits offered by PPF it definitely is the best investment option for conservative investors. It's perfect for the money you don't need it for a long period of time e.g. money for your children's eduction, money for your retirement, money for your daughter's marriage etc. On the other hand, our plain old good friend FD is best for multiple purposes. You can put how much money you want, you can invest for any number of years depending upon your wish and can withdraw the money in one click from your online net banking account.

Currently, Fixed deposit is offering really good returns for all tenures. An 8.75% quarterly compounded interest rate is very good even after considering inflation risk. But as I said before, if you can take some risk put at-least half of that money into equity. Equity via Mutual fund is more likely to provide better returns than PPF and FD for period like 15 years, especially if you consider developing economy like India.

8 comments:

Just to share an update on Public Provident Fund Limits, In recent budget presented by NDA government, PPF limit is raised to 1.5 lakh and section 80C tax benefit limit is also raised upto 1.5 lakh. Which means, now you can invest more than 1 lakh in each of your PPF account, your son's or daughter's PPF account.

I think main difference between PPF and fixed deposit comes from the total money perspective. If you invest 1 lakh every year for 15 years, you will create a corpus of approximately 35.7 lakh, given 8.7 percent of tax free returns. If you are in the 30 per cent tax bracket, she would save Rs 30,000 in taxes yearly. For 15 years, those savings add upto Rs 4.5 lakh. So total return from the PPF over 15 years is approximately 35.5 lakh, given no tax on maturity. However, if you had deposited Rs 1 lakh in a fixed deposit for 15 years at an interest rate of 9 percent per annum, assuming your tax bracket of 30 per cent, you would have made only Rs 25.31 lakh, since the earned interest attracts tax. That's a difference of over Rs 10 lakh in 15 years. That's huge money, approximately 1/3 of your total corpus. So, PPF is always better than fixed deposit. Also if you want to save money for your daughter's education, open a PPF account for minor, you can operate that account and can invest upto 1 lakh every year. This will be different than your own account.

Before reading this article I was also confused about PPF and FD. I think that you are doing a great job here because your article is helpful for those people who want to invest in Public Provident Fund and Fixed Deposit.Feel free to update us form this type of relevant information about investment.